February 11, 2006

Mind the splash…

In today's Guardian:

Imagine you are an investor who has bought financial assets in a country that's running a trade deficit of 5.8% of its national output. Imagine, also, that the size of that deficit grew by 17.5% last year…The country we are talking about is not Mexico or Thailand but the United States, which yesterday announced a record trade deficit of $726bn (£415bn) for 2005…Clearly, trade deficits of 6% of GDP are unsustainable. Clearly, the dollar has to fall. Simple game theory suggests that there is a real advantage in being the first central bank to move.

So the American economy looks set to do a Peter Kay-esque running bomb and surely we're all going to get soaked?

Well, yes and no. Stock markets will take a big hit if economies – especially Asian ones – start selling dollars. But in reality, this is surely just going to be a blip. Won't there be a certain amount of relief in the City and other institutions if the inevitable finally happens and the dollar finally comes down to a more sustainable position? Won't it reel in President Bush's unrealistic low-tax, high-spend philosophy? Won't investors realise that not a huge amount of our trade takes place with the US, and that as long as we have strong trading links with the EU, everything will be alright? And won't it be seen as a boost to our economy, as investment here might suddently appear more attractive?

Or am I being a hopeless optimist?

- 2 comments by 1 or more people Not publicly viewable

  1. If the value of the dollar falls, surely it'll be a boost for tourism, at the very least. (every cloud…)

    11 Feb 2006, 23:35

  2. I haven’t seen the full article, but it’s worth mentioning that the numbers in the quoted paragraph mean little in and of themselves. There’s nothing inherently desirable about a trade surplus or deficit, nor is there any reason why either couldn't be sustained indefinitely.

    Discussions of trade deficits are framed negatively in the press because, incorrectly, every instance of lack is deemed a problem. An increase in the trade deficit is also defined as an increase in the ‘capital account surplus’; now that doesn’t sound nearly as harmful! Talk of deficits as opposed to the definitional equivalent surplus causes incorrect conclusions to be drawn.

    A trade deficit is only possible if foreign investors are willing to purchase dollar denominated assets with the currency received from Americans. It makes no sense to receive dollars, then stick them in a box somewhere. Foreigners will accept dollars only if they deem the prospects of the US economy to be positive. An increase in the trade deficit thus implies an improved perception of the US economy/the value in holding dollars amongst foreign investors. Unless the article outlines why foreign currency holders are misguided as regards their belief in US economic fundamentals, statements about the deficit being ‘unsustainable’ are vacuous.

    12 Feb 2006, 01:49

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